Macro Final Exam Study Guide1. Chapter 1: The economic approacha. Economics-is the study of how we make choices under scarcity.i. Choice – The act of selecting among alternativesii. Scarcity – The concept that there is less of a good freely available from nature than people would like.1. ex. Time, money, textbooks 2. Scarcity necessitates rationinga. Rationing – Allocating scarce goods to those who want them.b. In a market economy, price is used to ration goodsc. Scarcity leads to competitive behavioriii. Resources-An input used to produce an economic good 1. Human resources (human capital)2. Physical resources (physical capital)3. Natural resourcesa. Capital: Human-made resources used to produce other goods and services.iv. 8 Guideposts to Economic Thinking 1. Resources are scarce so decision makers must make trade-offs (No such thing as a free lunch).a. Opportunity Cost: The highest valued alternative that must be sacrificed when choosing an optioni. Ex. An hour of your timeii. Ex. Guns and butter2. Individuals are rational: they try to get the most from their limited resources. “greatest benefit at least possible cost”a. Ex. Red Wine vs. Spiced Rumb. Ex. welfare vs. education c. Note: What is rational for one person may not be rational for everyone3. Incentives matter: choice is influenced in a predictable way by changing incentives4. Individuals make decisions at the margina. Marginal: Describes the effect of a change in the current situationi. ex. Olive Gardenii. ex. Trip to Taco Bellb. *Cost-benefit analysis: one will undergo an action when the marginal benefits outweigh the marginal costs*i. ex. Airport Security vs. Lead Clean-Up5. Information helps us make better choices, but is costly. a. ex. New house vs. new note book6. Beware of secondary effects: economic actions generate both direct and indirect effectsa. Secondary effects: the indirect impact of an event or policy that maynot be easily and immediately observable.i. ex. Fuel efficiency regulationsii. ex. Trade restrictions7. The value of services is subjectivea. Because goods are subjective, voluntary trade creates valuei. ex. How much would you pay for a pack of gum… right now?ii. ex. Moving goods and services to those who value them most is a primary source of economic progress.8. The test of a theory is its ability to predicta. If real world events are consistent with a theory, then that theory is validv. Positive vs. Normative1. Positive economics-the scientific study of what is. (testable)2. Normative economics-Judgments about what people think “ought to be”. (not testable) vi. 4 pitfalls to avoid in economic thinking 1. Violation of ceteris paribus principlea. ceteris paribus: other things constant i. ex. Buying Eggs 2. Good intentions do not guarantee desirable outcomesa. ex. Suicide warnings on antidepressant medication.b. ex. C&H Taxi3. Association is not causationa. ex. Superstitions b. ex. Sunspots and economic activity4. Fallacy of composition: belief that what is true for one might not be true for alla. ex. When you get a raise Vs. When everyone gets a raisevii. Microeconomics vs. Macroeconomics 1. Microeconomics: focuses on how human behavior affects the conduct of affairs within individually defined units such as households or firms (the trees)2. Macroeconomics: focuses on how human behavior affects outcomes in highly aggregated markets such as the nations market for labor (the forest).2. Chapter 2: Tools of the economista. Trade creates value-Because the value of goods is subjective, voluntary trade creates valuei. When Individuals engage in voluntary exchange, both parties are made better off.ii. Channeling goods and resources to those who value them most increases the wealth created by a society’s resources 1. Creation of wealtha. The process by which some people become rich will make everybody richer.i. ex. Henry Fordb. Importance of property rightsi. The right to exclusive use of the propertyii. Legal protection against invasion from other individualsiii. The right to sell, transfer, exchange, or mortgage the property1. 4 incentives of property rights a. Incentive to use resources in ways that are considered beneficial to others.i. ex. South Park: Cartmen’s Amusement Park owners bear the cost of ignoring the wishes of others.ii. ex. Reselling your textbookb. Private owners have an incentive to care for and manage what they owni. ex. Communal refrigerator vs. Your own refrigeratorc. Private owners have an incentive to conserve for the futurei. ex. Tragedy of the Commonsii. ex. Endangered species (pg. 27)d. Private owners have an incentive to make sure their property does not damage your property2. Lack of property rights = lack of economic progressc. Production Possibilities Curve (PPC) -outlines all possible combinations of total output that could be produced, assuming a:i. fixed amount of productive resourcesii. given amount of technical knowledgeiii. full and efficient use of resources1. 4 factors that shift the PPC a. A change in the economy’s resource basei. Investment: the purchase, construction, or development of resourcesb. Changes in technologyi. technology: the knowledge available in an economy at any given time. c. A change in the rules under which the economy functionsd. Changes in work habitsd. Law of comparative advantagei. The total output of a group of individuals, an entire economy, or a group of nations will be greatest when the output of each good is produced by whoever has the lowest opportunity cost.e. Economic organizationi. Every economy faces 3 questions1. What will be produced?2. How will it be produced?3. For whom will it be produced?ii. Capitalism: A system of economic organization where: 1. Productive resources are owned privately2. Goods and resources are allocated through market prices3. Market organization: a method of organization in which private parties make their own plans and decisions with the guidance of market pricesiii. Socialism: a system of economic organization where:1. Ownership and control of the means of production rest with the state2. Resource allocation is determined by centralized planning3. Collective decision-making: the method of organization that relies on public sector decision making to resolve basic economic questions.iv. Why Capitalism tends to work1. Capitalism is similar to natural selection. It uses the idea of market efficiency2. Socialism suffers from an
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